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Zynga, Inc. (ZNGA - $2.63)* BUY San Francisco, CA Price Target : $3.50 January 12, 2017

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Zynga, Inc. (ZNGA - $2.63)* BUY San Francisco, CA Price Target : $3.50 January 12, 2017 Zynga, Inc. (ZNGA - $2.63)* BUY San Francisco, CA Price Target : $3.50 January 12, 2017 Stock Data Operating Data Closing Price On Report Date $2.63 Revenue in $000 2016 2017E 52-Week Range $1.78-$3.08 1Q $186,721A$ 189,226 ADTV (10day) 9,000,000 2Q $181,735A$ 189,445 Market Cap ($000) $2,320,733 3Q $182,424A$ 196,884 Earnings Data 4Q$ 185,898 $ 207,608 December FYE 2016* 2017E FY$ 736,778 $ 783,163 1Q$ (0.03) $ (0.01) EBITDA in $000 2Q$ (0.01) $ (0.01) 1Q $16,035A$ 27,010 3Q$ (0.05) $ (0.02) 2Q $18,647A$ 29,761 4Q$ (0.03) $ (0.02) 3Q $3,580A$ 20,607 FY$ (0.11) $ (0.06) 4Q$ 12,969 $ 28,979 *4Q16E FY$ 51,231 $ 106,357 The WORD is CASHFLOW We believe that the common stock of Zynga Inc. (ZNGA) is undervalued, perhaps materially, at current trading levels. The stock has performed poorly for the last several years, but we believe that a new CFO and the fact that the company has finally attained consistent positive free cash flow could be the catalysts that propel the stock forward. We believe the common stock is worth at least $3.50 per share, and could be valued significantly higher in an M&A transaction. • Compelling Opportunity in Mobile Gaming. The mobile gaming space is an infant industry, which has a bright long-term future. ZNGA is a veteran player in a rapidly evolving space. The company has established a solid portfolio of games with a broad mix that appeal to a wide variety of mobile gamers. ZNGA has a bright future, either on a stand-alone basis, or as part of a larger company. • Positive Cash Flow Should be a Catalyst. ZNGA has generated positive operating cash flow in in each of the last four quarters and we expect operating cash flow to steadily grow going forward. The company also reports over $18 million in free cash flow in the first three quarters of FY16. • New CFO Likely to Rationalize Expenses, Growing Free Cash Flow. New CFO Gerard Griffin joins ZNGA after 10 years at Electronic Arts (NASDAQ: EA), and has vowed to closely examine each expense and we expect to see some rationalization. A $100 million expense reduction goal has been discussed. • Share Repurchase Program Should Stabilize Stock. The company has announced a $200 million share repurchase program, which should help stabilize the price of the equity while investors wait for free cash flow to drive it higher. • Valuation Implies Strong Possible Returns on Equity. We value ZNGA at a blended average of 16.0x our projected FY17 EBITDA of $106.3 million and 3.4x projected FY17 revenue of $783.1 million, which provides an average enterprise value of $3.14 billion. This valuation implies a 12-month price target for the company’s common stock of $3.50, which offers a potential return in excess of 30% if the stock trades to our price target over the next 12 months. David P. Marsh, CFA 410-299-3017 [email protected] Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/29/2021 Company Description: Zynga Inc. (ZNGA) is a leading provider of social game services for mobile devices and social networking sites such as Facebook. Their games are free to play, but offer in app purchases, which is one of ZNGA’s two revenue streams. The other primary revenue stream comes from third party advertising within the company’s games. The company offers a wide variety of games in an attempt to appeal to appeal to the broadest possible audience of mobile gamers. Slot machine apps are their largest revenue producer, followed by Farmville and Zynga Poker. Possibly the company’s best known title, Words with Friends, generates less than 1% of overall revenue, but has certainly seen an uptick in advertising spend recently. The following images are logos for some of the company’s featured games: The company’s most recent release, Dawn of Titans, created by the recently acquired NaturalMotion Limited, is in the action strategy category. It is an interactive game that facilitates player versus player battles and team competition. These titles usually drive substantial in game player spending if they successfully attract a substantial enough audience. Early reviews of the game seem quite positive, with an average rating of 4.5 out of 5 stars across 4,548 reviews in the iOS App Store. In total, the company currently offers gamers 31 titles across four broadly defined categories. Social Casino games are the company’s largest grossing category and include Hit it Rich Slots, Spin it Rich Slots, Wizard of Oz Slots, Willy Wonka Slots, and Zynga Poker. Action strategy games include the aforementioned Dawn of Titans, CSR Racing 2, and Empires and Allies. Casual games include possibly the company’s best known title, Words with Friends, as well as Chess with Friends, and Wizard of Oz: Magic Match. The final category, termed Invest Express , includes all of the Farmville titles. David P. Marsh, CFA 410-299-3017 [email protected] Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/29/2021 Customers: The company has operating agreements with Apple, Google and Facebook, and these three operating platforms serve as the medium through which the company acquires both gaming and advertising customers. The majority of the company’s revenues come from individual gaming customers, spending real money on in app game purchases. The collective slot machine titles accounted for 35% of revenue in 3Q16, followed by the Farmville titles at 21%, and Zynga Poker at 19%. No other title generated more than 10% of revenue. Competition: The mobile gaming segment is still a relatively young industry, since smart phones have essentially existed for less than a decade. But the segment is evolving rapidly. ZNGA is an established veteran competitor in this industry. The company considers principal competitors to include DeNA Co. Ltd. (Japan), Electronic Arts Inc., Gameloft SA, GREE International, Inc., Glu Mobile Inc. (NASDAQ: GLUU), King.com Inc. (now owned by Activision Blizzard), Rovio Mobile Ltd., Supercell Inc., GungHo Online Entertainment, Inc., Kabam, Activision Blizzard, Inc. (NASDAQ: ATVI), Riot Games, and The Walt Disney Company. Certain of these competitors are material threats, due to their larger size and substantial financial resources. However, they also represent potential acquirers, in a space that has already seen substantial consolidation. Financial Results First 3Q FY16: Revenues down 4.8% Versus First 3Q FY15. ZNGA generated total revenue of $550.8 million in the first nine months of FY16, which represents a 4.8% decline versus revenues of $578.9 million in the first nine months of FY15. Online game revenue was down 11.7% year-over-year, but advertising and other revenues were actually up 22% year-over-year. EBITDA Declines 51%. We calculate EBITDA of $38.3 million in the first 3Q of FY16, which is about 51% lower than the $78.3 million we estimate was generated in the first 3Q of FY15. However, if we exclude the impacts of contingent consideration fair value adjustments related to acquisitions, EBITDA was only down 18% year-over-year. We expect the noise related to the acquisition earn out to work itself out of this calculation in short order and expect EBITDA to grow with expense rationalizations in the very near term. Positive Free Cash Flow. ZNGA has generated positive operating cash flow in each of the last four quarters and positive free cash flow in each of the last four quarters as well, albeit modest amounts in some of those periods. The company has generated approximately $18.4 million in free cash flow in the first 3Q of FY16, and we expect that tally to grow in 4Q. David P. Marsh, CFA 410-299-3017 [email protected] Downloaded from www.hvst.com by IP address 192.168.160.10 on 09/29/2021 4Q16 and FY17 Outlook: The company’s 4Q16 results are expected to show sequential improvement versus 3Q16, and we are modeling steady growth in revenue and meaningful growth in EBITDA for FY17. Revenue Expected to Rise 1.9% sequentially in 4Q16 and 6.3% in FY17. We are modeling 4Q16 revenues up 1.9% sequentially to $185.9 million versus $182.4 million in 3Q16. For FY17 we are modeling revenues of $783.2 million, which would be up 6.3% versus our FY16 forecast. EBITDA expected to grow 262% sequentially in 4Q16 and 108% in FY17. We expect the company to generate $13.0 million in EBITDA in 4Q16, which would be up 262% sequentially versus the $3.6 million in EBITDA generated in 3Q16. For FY17, we are modeling $106.4 million in EBITDA, which would be up 108% year-over-year, versus the $51.2 million in EBITDA we have modeled for FY16. We expect that revenue growth, coupled with expense rationalization as a percentage of revenue will drive the significant growth in EBITDA. We also expect that contingent consideration fair value adjustments related to prior acquisitions will fall out of the EBITDA calculation going forward, as acquired businesses are paid their final earn out payments and results are fully integrated into ZNGA’s bottom line. FCF Expected to Grow Significantly in FY17. With higher EBITDA and rational capital spending, we believe pre-tax FCF could grow to approximately $83 million in FY17. EPS may continue to be “on the come” for the company, as a significant portion of compensation continues to be in the form of equity based awards.
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